• Upgrade 2017 average CPO price by 11% to RM2725/MT from RM2450/MT

• Beneficiary of strong USD

• Inventory to dip below the critical level of 1.5m MT in 1QCY2017

• US record high biofuel mandate is positive for CPO price

• Strong CPO price seen in 1H2017; 2H2017 outlook will depend on Indonesia biodiesel consumption

• Maintain POSITIVE view on the sector; Upgrade SIME to BUY (New TP: RM9.05)

• KLK (TP: RM29.25) is our top pick. We also have BUY calls on IOICORP (New TP: RM5.30) and TAANN (New TP: RM4.70)

Upgrade 2017 average CPO price by 11% to RM2725/MT from RM2450/MT. Reasons for the increase in CPO price assumption are: i) CPO stand to benefit from strong USD, ii) we expect inventory to dip below the critical level of 1.5m MT in 1QCY2017, and iii) US record high biofuel mandate is positive for CPO price. For 2016, we have increased our average CPO price to RM2625/MT (from RM2450/MT).

Beneficiary of strong USD. CPO price stands to gain from the strong USD as it gains competitiveness against soybean oil which is priced in USD. A strong USD should increase the demand for CPO as it will be cheaper for consumers to use palm oil instead of soybean oil. We have incorporated the latest assumption of 2017 average USDMYR rate of RM4.20 for our CPO price estimate.

Inventory to dip below the critical level of 1.5m MT in 1QCY2017. Malaysia palm oil stockpile is expected to drop below the critical level of 1.50m MT towards in 1QCY2017. The impact of El Nino on oil palm tree production is still lingering and we expect production to recover only in 2QCY2017. Coupled with the seasonal low cycle in first quarter, CPO production will not be enough to satisfy demand. As a result, inventory is expected to drop to the range of 1.45m to 1.50m MT by end-Feb 2017. This is a positive factor to CPO price which we think has not been fully realized by the market.

US record high biofuel mandate is positive for CPO price. Recently, United States has increased its biofuel mandate by 6% to 19.28b gallons in 2017 which is a new record. The news has caused soybean oil price to surge in the Chicago Board of Trade (CBOT) market. Note that soybean oil is the main input used to produce biofuel in the US. In August-2016, 54% of the total input used to produce biofuel in US came from soybean oil. The news is positive to CPO price as it is used as a common substitute to soybean oil.

Strong CPO price seen in 1H2017; 2H2017 outlook will depend on Indonesia biodiesel consumption. We expect 2017 to be “a year of two halves” – the first dominated by ongoing low stockpiles at well below 2.0m MT; the second by the strong palm oil production recovery especially in Indonesia. For 1H2017, we expect CPO price to stay at the higher range of RM2800/MT to RM3300/MT. As for 2H2017, the strong production recovery should limit CPO price upside but we see downside to be well supported at RM2300 per MT. If Indonesia biodiesel industry continues its excellence in absorbing the additional supply, we may see the downside at RM2500/MT.

Maintain POSITIVE on the sector. In line with higher CPO price assumption, we have increased our earnings assumption for FY16 and FY17 for all planters under our coverage. Accordingly, our Target Price has been increased for all planters except FGV which is maintained as we are using 1.0x Price to Book Value method. For PPB, we are changing our valuation method to 1.0x Price To Book Value as we noticed that the stock price stability reflects its Book Value rather than the volatile earnings of the Company. Refer Table 1 and Table 2 for full details of changes in Calls and Target Price.

Upgrade SIME to BUY (New TP: RM9.05; Old TP: RM7.70). We have upgraded SIME due to: i) its plantation division is set to benefit from high CPO price, ii) expected positive newsflow from the potential demerger exercise to unlock its value and iii) decent dividend yield of 3.8%.

Top pick is KLK (New TP: RM29.25; Old TP: RM29.05). Our top pick is KLK due to: i) 70% of its EBIT is from upstream palm oil plantation business, ii) positive outlook for downstream division from new capacities in the fatty acid business and iii) good track record in earnings delivery historically.

Other BUY calls are for IOICORP (New TP: RM5.30; Old TP: RM5.05) and TAANN (New TP: RM4.70; Old TP: RM4.50). We like IOICORP due to its pure exposure to palm oil business both in the upstream and downstream divisions. The Company’s profit is also expected to recover in FY17 after the uplift of RSPO suspension. We also like TAANN due to: i) its FFB production growth is the strongest among peers (+8%yoy in 9MFY16), ii) better outlook for timber division due to recent strengthening of USD and Sarawak State Government’s effort to promote timber products in Japan.

Source: MIDF Research - 7 Dec 2016